What a difference a year makes. Do you recall how 2016 started? The United States’ Federal Reserve announced the first interest rate hike in years in December of 2015, and the S&P 500 would then plummet almost 11% over the following 8 weeks. At the same time, Japan and a number of European countries initiated negative interest rate policies in attempts to promote economic growth. The European Central Bank (ECB) messaged its ability to provide additional stimulus to the Eurozone, similar to the way the US’s Fed extending Quantitative Easing several years ago. And China flexed its monetary muscle by pumping more cash into its financial system. To top it all off, S&P 500 companies were working through a painful earnings recession, which would end up spanning five quarters.
Fast forward to 2017, and we’ve now seen two consecutive quarters of earnings growth on top of considerable optimism around the new Trump administration, all of which we’ve discussed at length in recent newsletters. There are still many variables in play—there’s always a big mixed bag of variables in play—but the key issues still mattered in March:
1) interest rate policy, which is largely influenced by …
2) … economic data (unemployment, inflation, wages, spending, etc.), and now …
3) … legislation (markets are mainly focused on tax reform, deregulation, and health care) seems to have stolen some attention from …
4) … oil prices and energy sector volatility.
The major benchmarks lost some ground during March for the first time since the US election last November. The Dow Jones Industrial Average started March by closing above 21,000 (cue the fireworks for arbitrary milestones), but ultimately the Dow would finish the month -0.72% lower. The S&P 500 and the Russell 2000 (a benchmark of small company stocks) also posted tiny losses for the month at -0.04% and -0.05% respectively. The MSCI Developed EAFE (international large company stocks) finished about 3.23% higher in March, and that sector now leads the S&P and Dow year-to-date. Emerging Market stocks also finished about 3.69% higher for March, and they’ve climbed more than 11% over the first quarter. Also of interest, growth stocks are outperforming value stocks YTD.
The Barclays Capital Aggregate Bond Index (high-quality bonds) posted a very small loss for March, but is still holding onto a positive total return of 0.7% YTD. Foreign and emerging market bonds are outpacing domestic bonds, similar to what we’re seeing in stocks.
INTEREST RATE POLICY and the ECONOMY
Bond yields climbed a little higher following the Fed’s decision to move the Fed Funds Rate up another 0.25%. (When policy-makers hike interest rates, bond prices typically fall, which makes their yields increase.) The street view is for another one or two rate hikes this year, and the Fed has messaged as much. Their plan is to incrementally raise rates because they view the economy as healthy and in less need of their assistance. Fed Chair Janet Yellen said, “The simple message is the economy is doing well.” Her claim was bolstered by a March jobs report that came in better than expected, and year-over-year inflation readings that are now in line with the Fed’s mandate (inflation around 2%). The jobs picture is also healthy in terms of the Fed’s mandate, with unemployment at or below 5%.
Optimism was markedly high after President Trump’s recent address to Congress, where he advocated policies he claims will protect the American people and bolster the economy. However, some of that optimism waned when the vote on the American Health Care Act (the intended replacement for the Patient Protection and or “Obamacare”) was pulled from the House floor on Trump’s imposed deadline day when it became apparent the bill didn’t have the votes to pass. His 2018 fiscal budget blueprint has been released, and it shows increased spending on defense, homeland security and veteran affairs, and decreased spending on a number of domestic programs, environmental protection, and foreign aid. Trump is also pushing for a major infrastructure spending boost, to the tune of $1T. This spending item may be warranted. Data published by the American Road and Transportation Builders Association shows that 28% of our nation’s 612,079 bridges are least 50 years old and have never received any major reconstruction work.
Whether you like these policies or not, the failed healthcare vote seems to have investors questioning Trump’s ability to get legislation to the finish line. It’s expected that his efforts will now move on to tax reform. Ultimately, a sustained winning streak for stocks turned into a losing streak over the back half of March as it became clear that changes promised during the election season will be legislatively harder to grind out than many had initially thought.
OIL and ENERGY STOCKS
The near-term direction of oil prices is still out of focus. The Good news: The International Energy Agency (IEA) reported that OPEC countries are 98% compliant with the recently agreed upon production cut, and non-OPEC member, Russia will purportedly reduce production in stages to support OPEC’s strategy. The Bad news: the IEA also reported that the global oil supply glut is still a problem, meaning more price instability, and recent U.S. Inventory reports corroborated that assessment.
One of the big problems that we’ve discussed in previous editions of the newsletter is that U.S. hydraulic fracking technology is just “too good.” Here’s some data from Baker Hughes: operating oil rigs in the US (both on land and offshore) as of 5/27/16: 404, operating rigs as of 3/24/17: 809. When the frackers see prices climb a bit (thanks, OPEC!), they can flip a switch and turn their rigs back on and start making money again. The healthy outcome of more producing rigs is increased production and lower prices, which counters OPEC’s strategy.
This is a big reason why Saudi Arabia is raising capital via an IPO of its state-owned Aramco – it wants to reduce its exposure to the volatile oil market and use the cash to diversify into other things. The Saudis have hired a few big players (JP Morgan, Morgan Stanley, and HSBC) to facilitate the IPO roll-out of what is expected to be the world’s largest equity sale. How bad has it gotten for some OPEC members whose only real asset to sell the world is oil? Well, consider Venezuela. The government there recently had to tackle a bread shortage by . It’s been really ugly down there for a while.
Daylight Savings Time was rough this year. We all may know some people who say they still haven’t gotten adjusted, but you have to deal with it anyway. There are a lot of people who would say the same about the Trump administration, or any new administration taking office for that matter. Think about the last regime change on Capitol Hill. Heck, go across the pond and look at last year’s heated Brexit vote, which, by the way, will finally formally begin now that British Prime Minister Theresa May has invoked Article 50 of the Lisbon Treaty. The Brits are officially saying goodbye to the European Union.
In hindsight, it’s apparent that US stock market investors were fine with last year’s election, but there’s an aspect of the “Trump Trade” that’s not getting as much attention as it should. Earnings will come back in focus this month with a large majority of S&P companies set to report Q1 numbers soon. We’re now eight years into this bull market, which has shaken off four corrections of 10% or more, not to mention a smattering of smaller, but steeper, mini-corrections. Volatility has been mostly muted since the election, and we’ve obviously seen some recent downward pressure. Prior to the healthcare-fail, the March Fed rate hike sent everything higher mid-month … stocks, bonds, even gold. With stock and bond valuations both above their long-term averages, and therefore more susceptible to a drop, we believe it’s critical to remain focused and disciplined.
We finally got the highly anticipated rate hike at the Fed March 14th meeting. Although the Aggregate Bond index was down slightly for the month, it rallied 1.24% from the low on March 14th. Our core portfolio continues be fully invested and at the end of March outperformed its benchmark by a slight margin. We will be performing a rebalance of the portfolios in April. You might see some small trades on both the buy and sell side but just know these are not changes only adjustments to keep the portfolio in-line with our allocation percentages.